Fiscal support is from taxpayers, not helicopters

The economic impact from Covid-19 has already been unprecedented in its severity and speed, prompting governments across the globe to offer extraordinary levels of fiscal support to ameliorate the impact on households and businesses. As a consequence budget deficits will soar, raising the question of how they will be funded. The fact that some of the additional government spending has come in the form of cash payments to households or direct wage support has prompted references to ‘Helicopter money’, although that is to misunderstand the concept and indeed how these deficits will be funded,which as it stands will be from existing and future tax payers albeit with the caveat that central bank actions can reduce the interest bill.

The term ‘Helicopter money’ was coined in 1969 by Milton Friedman, musing on the impact of a one-off increase in the money supply, in this case via the drop of €1,000 dollar bills from the sky (it would simpy raise prices he thought). More recently the idea re-emerged in the noughties as central banks started to worry about deflation and has also become associated with Modern Monetary Theory or as some call it, the ‘Magic Money Tree’. This contends that money is essentially a fiscal creation and that a government with monetary sovereignty, such as the US or UK, can fund additional spending by printing money rather than through taxes, albeit in the modern world through the central bank simply crediting a balance in the State’s account at the bank. Note that euro member states do not have monetary sovereignty and the ECB is prohibited from monetary financing.

What is striking though is that,to date at least, the huge sums that governments have committed to spend are seen to be funded by borrowing. The partial payment of wages by the State, for example, is no different from the payment to recipients of unemployment or other social welfare i.e. it is a transfer from tax payers, paid out of current tax receipts or from future tax receipts by borrowing.

Consequently, Government debt levels will rise steeply, as in many cases deficit ratios will balloon to double digit levels, although that depends on the duration and severity of the recession unfolding before us. In Ireland’s case the Central Bank (CB) has recently projected an Exchequer deficit around €20bn this year, which if broadly right implies a major increase in debt issuance. That had been put at up to €14bn, against €19bn due for redemption because the NTMA had intended to run down some of its cash balances which amounted to €15bn at the beginning of the year. The implication now is that a €10bn reduction in cash balances would still require around €30bn in issuance of new debt.

The NTMA have already issued €11bn to date and of course the interest rate on the debt is very low, albeit higher than it was a few months ago, so debt is being redeemed and replaced at a much lower cost, reducing the average interest rate on the outstanding debt, which is now down around 2%. QE is helping of course, which allows the ECB and the (CB) to buy up to a third of any issuance and hold up to a third of debt issued. That means that most of the interest on that QE debt is paid to the CB , boosting its income and hence largely returned to the Exchequer as CB profit.

This is not helicopter money as the bonds at issue will have to be repaid, most likley by issuing new debt on redemption, which implies QE will be never ending unless economies are strong enough for private investors to buy all of the new debt issued. There is also an additional contraint on QE in the euro area in that bond buying is broadly proportionate to each member’s population and GDP, which determines the ‘Capital Key’ ( share of the ECB’s capital subscription). In Ireland’s case it is around 1.5%, so Irish government bonds held under QE amount to €34bn out of a total of €2261bn .

The Covid pandemic and resulting economic crisis has prompted the ECB’s new Pandemic Emergency Purchase Programme (PEPP) which does appear to include the capital key constraint but not the issue limit. It is designed to run this year with a size of €750bn and therefore in theory could buy most or all of a new bond. Ireland might issue €15bn in a 30 year pandemic bond, for example, and the ECB could buy say €12bn, with most of the interest therefore paid to the CB. All this helps to reduce interest costs but is not the same as printing money to give to individuals, via bank transfer or from a helicopter.